Excess Spread - Doom and gloom, time to get weird, Barca ahoy
- Owen Sanderson
Doom and gloom
Flicking through the research notes in my inbox they all have titles like “Price fall”, “Spreads widening”, “underperformance”, “Stagflation fear”, “Wake up call”, “Darker clouds”, “Markets on the brink” and “Capitulation in sight”. Things ain’t good out there. The war risks might be increasingly priced in, and the market had sort of stabilised at wider, weaker, wobblier levels, but another round of central bank-induced puking is the order of the day.
As ever, the ABS market reacts slower to broader sell-offs, but it’s still not looking good. Relative value matters — the sell-off in Crossover a few weeks back had a read-across to sub-IG mezz prints in primary, with the buyside seeing the right level as a multiple of Crossover, and issuers hoping for a fixed spread. That seemed to go very much in favour of the investors...when there are only one or two buyers, they can name a price — so let’s see what this week’s primary brings.
PSA (Peugeot’s financing arm) is selling a full stack Spanish auto loan deal, while auxmoney is in market with its second deal after last year’s award-winning debut, also looking to place right down the capital structure.
The slim investor base at the bottom of the stack problem is less acute in euros, and STS certification and ECB eligibility should help place the senior but Crossover is wider than ever, opening 7 bps wider at 469 bps on Tuesday (it’s since tightened again to 451 bps on Thursday). If we assume single-B mezz at 1.5x Crossover then....ouch.
PSA has added a rider to its deal announcement clarifying that it could “retain (fully or partially) the relevant class, depending on pricing conditions”....applied to every single class on offer.
That’s sort of implicitly the case in every deal out there — I imagine Centerbridge, majority owner of auxmoney, has a level where placing deep mezz is uneconomic — but spelling it out up front is a bit of a hedge to potential embarrassment should market conditions blow the deal off course.
The challenging market vindicates the banks which said “go early” as the market reopened after the Russian invasion.
The deals done before Easter were tough syndications and not all went to plan (Apollo’s Prinsen Finance had to cut deal size, for example), and it didn’t escape the notice of market participants that most of the issues were BNP Paribas deals.
But a month later, the window looks, if anything, even tougher, and there’s a lot of takeouts lining up probably aiming to get done before Global ABS. At this point, is there any issuer with confidence that conditions are going to get much better this side of the summer break?
Short and sweet
Capital Four kept the CLO primary market alive last week, printing Capital Four CLO IV on Friday via JP Morgan.
With a one year non-call and two year reinvestment period, it’s one of the shortest CLOs seen in the market (apart from the Palmer Square static deals which, obviously, have no reinvestment period). It follows last week’s Madison Park Euro Funding XV reset and Aurium X Aurium X, both 2NC/5RP deals, a structure longer than most of the market in 2020 and 2021.
That underlines the different strategies for handling current market conditions....it’s not just a question of market bad = shorten tenor, as in the post-Covid period. Managers and equity providers clearly have very divergent views on when markets will recover and what kind of optionality is worth paying for. If you see a recession inbound, the extra time to manage through the situation could be crucial, but if you expect a short sharp shock, then minimising liability costs out of the gate is the best plan.
Not that there’s a huge amount of paying for extra time going on.
Capital Four senior notes landed at 112 bps vs 115 bps for the far longer Spire Partners deal Aurium the previous week. Down the stack investors didn’t give much credit to the short-dated issue either, with the rest of the capital structure priced at 229/325/459/857/1050 vs 220/315/430/770/1050 for Spire.
Capital Four’s syndication must have run headlong into the Fed-driven carnage on Thursday and Friday, so the counterfactual comparison isn’t really there....just how much worse would it have been if it had gone out with a long deal?
Securitised products might be more resilient than a lot of markets, but on days like the back end of last week, it’s a big ask for investors to keep their levels in place. Crossover levels and triple-B CLO spreads seem to be intimately bound together right now, meaning there’s a very direct read-across from the highly liquid indices to the more rarified and bespoke CLO primary market.
Troubled times also throw up more secondary opportunities, taking investor focus off primary markets, and giving the buyside a bigger stick to beat syndicate — nobody has to play a new issue when there are plenty of secondary sellers out there.
In markets like we’ve seen over the past week or so, sheer execution speed matters — the volatile backdrop means in a typical two week leveraged loan syndication, or two to four weeks for a European CLO, there’s almost certain to be some sort of major move, panic, rally, panic again type cycle, making it brutally difficult to keep a book together at any kind of coherent level.
Conditions this week had some better moments, but remained very strained. Barclays-arranged Redding Ridge 12 came to market with a 2NC/5RP deal, adding an extra €50m to the planned deal size to snap up some dislocated assets (we called that a “print more and jog” strategy in the post-invasion selloff).
The pricing message thoughtfully left out the actual prices, so we’ll have to wait a little to see just how painful it was clearing the mezz, but the split in the triple-B tranche is weird and noteworthy — there’s a €24.3m C-1 tranche and a €7.2m C-2, notched lower with Fitch, featuring 15.4% par sub instead of the 17% for the C-1, and paying 433 bps instead of 423 bps.
This suggests something of a struggle to wrestle the triple-B over the line (or, more charitably, an innovative way to cater to multiple triple-B investors with differing price expectations).
There’s also no single-B note included in the capital structure, as has been Redding Ridge’s usual practice since the Covid crisis — but it’s weirder that other managers are still bothering with a tranche that’s basically uneconomic.
The 1050 DM level circulated for Capital Four IV and Aurium X single-Bs is costly enough on its own terms, but it’s arguably a little misleading depending on when the deal gets called, as the bonds are pretty discounted. A 951 bps coupon (in the case of Aurium) plus six points in two years (assuming a early call) gives an economic cost above the 12% incentive fee level.
Equity providers which are also active debt investors, or managers with their own risk retention capital (that’s most of what’s coming to market at the moment) might place single-Bs with their securitised products group, preserving the traditional fully levered structure, but keeping the generous single-B economics in-house — it’s not clear how prevalent these approaches are, but they make a lot of sense in today’s environment.
We hear the Creditflux conference on Tuesday this week was very well attended, and with a decent round of dealmaking activity off the main conference floor. That doesn’t necessarily mean a healthy market though — the conversations might have more of the flavour of “how on earth can we get this warehouse out” rather than “would you like to anchor our next three issues”.
Or the high attendance may simply reflect generally lessened activity meaning more freedom to leave the office. As one CLO trader quipped: “If I’m at a conference, they can’t hit my bid”.
Go do it Blackstone
We drank martinis with one of the top guys in European real estate debt this week, and picked his brains about the non-emergence of the CRE CLO market after last year’s landmark Starz deal.
According to him, there’s a fairly crucial imperative coming down the tracks to create this market — some of the big banks are starting to get tapped out on their repo lines to the top tier real estate debt firms. In other words, loan on loan capacity, the other main way to lever a portfolio of real estate debt, is under pressure.
The obvious fix for this is a capital markets solution like a CRE CLO — if the risk can be distributed, ideally in a format that’s recourse to the portfolio, not recourse to the sponsor, that should increase capacity and refresh bank lines.
To be honest, we found the basic premise a little surprising — the big players in real estate debt, the likes of Blackstone and Apollo, are the biggest clients in investment banking, period, the triple-platinum full-service best fee-payers. Servicing their every desire has been and will continue to be massively lucrative....surely they can borrow all the money they desire from the Street?
But, maybe not? This guy knows of what he speaks. Loan on loan financing is low LTV (there’s a haircut to the value of the debt, which in turn sits ahead of mezz and equity) and secured (it’s basically a repo, so the bank gets the loan if the counterparty doesn’t perform).
But it’s also illiquid and bespoke, given the real estate backing, pretty correlated (there’s no reason to think a Blackstone office loan and a Brookfield office loan wouldn’t go south together), and from a risk department’s point of views, it’s all lending to a given sponsor. That sponsor, in turn, may have big lines all over the Street which are imperfectly disclosed, just to give risk teams some fun Archegos flashbacks.
The real problem is probably the same issue which has hobbled the revival of European CMBS and the emergence of CRE CLOs — a lack of creative capital in the sector. If the banks could distribute the risk of their loan on loan facilities more easily, the problem goes away, and it doesn’t really matter whether that comes as an ISIN security like a CRE CLO or some kind of loan participation.
The market, as abundantly discussed above, is probably not in the mood to digest further challenging structures at present....if Starz had a brutal month-long syndication and landed wide of talk in October, how much worse would it fare today? But the market’s got to starting moving at some point.
We heard a variety of big name sponsors were looking at CRE CLOs around the end of last year, and would ideally have liked to get out ahead of Starz. Presumably those deals are still ready to go, and the banks are likely keener than ever to move some risk.
A brand name issue could be a real gamechanger.....as my martini counterparty (from a rival firm) put it, “it’s not really a thing until Blackstone does it”. So crack on, Blackstone.
Plenty of subtleties are emerging from the time we’ve spent looking at buy-to-let origination — and the extent to which lenders are writing loans at uneconomic levels. We cited Landbay as a securitisation-funded originator pricing loans at among the lowest levels out there, but we should point out it’s got a whole mix of funders, four of whom are challenger banks (it’s only disclosed Allica Bank and Atom Bank). DK, with an empty warehouse after January’s Stratton BTL issue, is likely looking for new high interest loans, perhaps with a specialty twist (perhaps HMOs, limited companies or similar).
It’s worth thinking about the different flavours of deposit bank in a rising rates environment — it’s not quite as simple as deposit funding good, securitisation bad. There are versions of deposit funding which pay pretty much nothing, accept salary payments and are incredibly sticky (HSBC has happily paying me nothing on my current account since 2008), and then there are versions which are highly geared to market conditions.
A quick look at the Notice Deposit market and fixed rate saving products show the likes of Paragon, Shawbrook and Aldermore topping the tables for interest rates, signalling that they too are feeling the pinch of rising rates. They may be have the flexibility to take or leave market executions in RMBS, but the competition remains tough on the liability side. You can get a five year fixed rate deposit paying 2.13% at Paragon, compared to a lowest BTL rate of 3.18%...that’s the right way around, at least, but times aren’t easy.
Hedging is another interesting angle, pointed out by one of our most thoughtful readers — in a rapidly rising rates environment, there’s a world of difference between hedging at application, which might have been three months back, at offer, at completion, or not at all.
Those loan buyers which hedged early are sitting on a M2M gain on their swap (they’re now receiving higher floating rate interest from their counterparty), but putting on a hedge now for a loan agreed at February’s levels is brutally expensive and leaves virtually no margin left in the product. Bank buyers of loans might be able to wear a little more interest rate risk, and have a natural hedge in their fixed rate deposits, but swap arrangements very much matter.
There’s likely to be some exposure left with the banks that offer securitisation swaps, too — these are all the same way around (swapping fixed rate to floating) so the market has moved against them. Bespoke securitisation swaps (usually a balance guaranteed swap) will be backed out to the market through regular interest rate swaps though, so the investment bank exposure depends on the size of the basis between the BGS and the market hedge. BGS desks which hedged their own books early and hard could even be ahead of the game.
Excess Spread’s email systems are evidently on the blink because the wave of Global ABS party invites seem to have been held up in cyberspace. If you’re on the fence about whether you want myself and my excellent colleague Kat eating your food and drinking your drink, consider this recent tribute to Deutsche Bank’s generosity — we understand the mandates have been flooding in since then.
Frankly we will probably turn up anyway, but it’s always nice to be legit. Obviously everything off the record and all that. Looking forward to seeing many of you in Barcelona soon, do say hello!
Time to get clever
Has the post-GFC structuring landscape got boring? Kinda yeah. Sure, there have been new asset classes, ESG, the rise of fintech, but without the re-regulation of the sector, the restless minds in securitisation structuring and law would have little to get their teeth into. Their illustrious predecessors invented enough new products to nearly blow up the world, and all we can come up with these days is risk retention vehicles?
We’ve talked a bit about CRE CLOs coming to Europe (as above), about the (absence) of middle market CLOs, and about why investors pay 50 bps and 20% incentive for levered investment in a sometimes samey basket of European loans (and whether it could be done cheaper).
But one actual gamechanger could be a better structure for insurance firms to invest in European CLOs.
There’s a big regulatory issue around Solvency II in Europe, but there’s also a structural problem. Insurers tend to like long-dated fixed rate assets, and CLOs are floating and generally callable in two years max. That’s a reflection of the source material, of course — leveraged loans are floating and callable in six months — but surely a more bespoke approach is possible?
In RMBS structuring, you can take off prepayment risk and give certainty of cashflows if you can bundle enough loans together in a master trust (usually because the master trust sponsor keeps that in the sellers share) or if an individual deal is large enough, you can bundle this risk off into another tranche and carve out an insurance-friendly issue.
Dublin Bay, the M&G-sponsored Irish RMBS issued in 2019, had a “matching adjustment” tranche tailored for insurance demand, which worked by pushing some of this risk into the other tranches, while the UK ICSL student loan deals did something similar, turning the frankly weird wage-linked payment profile into a fixed rate insurance-friendly tranche and an ABS-friendly Libor (now Sonia) linked floater.
But this basically relies having a very large pool of assets, and placing the exposure to floating rates / prepayments elsewhere in the capital structure. It would certainly be cool to get a deal like this away — more senior CLO investors are desperately needed — but lots of stars would need to align.